The Decennial Market Crash


The financial collapse of 2007 has often been compared to the 1929 stock market crash. Both had similar scandals related to the securitization of credit and an overly exuberant bubble atmosphere. But the parallels go much further than overinflated values. The 2007 financial collapse, being the third large-scale market crash in three decades, was evidence that laissez-faire economics and deregulation had finally returned the economy to the decennial market collapse cycle of the pre-war era.

Before the 1929 stock market crash, American and European economies crashed on an almost clockwork schedule every ten to twenty years. From the Bengal Bubble of 1769 through the Panic of 1893 and the Panic of 1907, asset values grew faster than their inherent worth. Irrational exuberance crumbled into feckless desperation on various Black Mondays, Black Fridays, and Black Thursdays. Prices plummeted and millions scrambled to pull out their money out of banks as quickly as possible. Certain keen investors made out like bandits while whole countries were instantaneously thrust into poverty and unemployment.

Not unlike the South Sea Bubble and the Mississippi Bubbles of previous centuries, investments that appeared as an endless cornucopia of wealth suddenly turned out to be figments of the collective imagination. In 2007, it was subprime lending and derivatives trading. In 1929, it was the collapse of investments in public utilities, investment banks, foreign bonds, Florida real estate, and Ivan Kreuger’s matchstick company Ponzi scheme that would help drive the economy into the ground. During the dot-com collapse, it was technology, energy, and health care stocks. In the 1800s it was railroads, currency, commodities, and real estate. The same corruption surrounding IPOs and favor trading during the dot-com boom was eerily similar to what happened during Boeing’s entrance onto the market in the late twenties. The accounting frauds of Enron and HealthSouth were not so different from the pyramiding of Samuel Insull’s General Electric whose value was buried in layers and layers of shell companies. Trading in derivatives without oversight is not so different from the boiler rooms and bucket shops of previous decades.

Each time, insiders and investment pools conspired to move the market and take advantage of the gullible with speculation, shorting, and fraud. Sapient nincompoops with access to more money than sense gambled themselves into holes that would drag the rest of the economy down with them. Conflicts of interest and perverse incentives would run rampant, encouraging fools to be taken advantage of by scoundrels. The gambling atmosphere would eventually overvalue investments and drain capital from the economy, inflating the bubble until it burst.

Economist Hyman Minsky long ago codified the investment bubble cycle as a common process in a market economy. Booms and euphoria lead to profits and eventually panic. But the regulated economy of the post-war era was surprisingly devoid of the bubble cycle. Many of the regulations put in place during the New Deal and the progressive era, from deposit insurance and the Federal Reserve to the Glass-Steagall Act and securities oversight, stabilized the economy for decades to come. Conflicts of interest were stymied and lending standards were enforced. The stock market became a sleepy corner of the financial world where nobody made millions overnight, but nothing fell apart either.

With the ascendancy of neoliberal doctrine in the late seventies and the anti-government philosophy of the Reagan administration, deregulation became the main focus of economic policy. Selective holes were punctured in the regulatory framework to allow more unsophisticated capital into the markets to gamble without restraint. The conflicts of interest that corrupted the market in years before were allowed right back in.

Savings & loans were released from oversight, allowing them to gamble without restraint in the stock market and write off their losses. Interest rate limits on loans were removed so that banks could charge unlimited amounts in what are now known as adjustable rate mortgages and subprime loans. Regulatory bodies like the SEC were rendered toothless from Reagan’s budgetary and policy constraints. Junk bonds built on relatively worthless real estate investments were then used as gambling chips for the rash of mergers and acquisitions throughout the decade.

By the time it was removed in 1999, the Chinese wall of Glass-Steagall Act that separated investment banks from commercial banks had already been under siege for the better part of two decades. Stephen Friedman, Reagan’s head of the SEC, called Glass-Steagall “the emperor’s new clothes” and intended to dismantle the legislation piece by piece.

Removing Glass-Steagall opened the door for the same sort of corruption that enveloped City Bank before the 1929 crash. At the time, City Bank was underwriting securities through their National City affiliate while promoting those same investments through the parent bank. With such a grand conflict of interest, they could take advantage of investors with ease. Ironically enough, it was the merger of Citigroup, City Bank’s descendant, that inspired the elimination of Glass-Steagall. While Citigroup was trading in collateralized debt obligations and betting against their own mortgages in the lead up to the 2007 collapse, City Bank sold overvalued Peruvian bonds that they had underwritten in the lead up to the 1929 crash.

Reagan’s lowering the capital gains tax rate made the whole enterprise a lucrative endeavor. Low tax rates on investment profits meant that all of the fraud, insider trading, chicanery, and foolish investment could create millionaires overnight. For those with access, massive amounts of capital could be borrowed to speculate on high-risk, high return investments through what Minsky termed “Ponzi borrowing.” If they were successful, they became instantaneous Donald Trumps. If not, they will have thrown money down a well that only serves to throw a wrench into the economy for years to come.

Llewellyn Hinkes Jones is a Washington, D.C., writer.

From The Progressive Populist, March 15, 2015

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